[Federal Register Volume 61, Number 247 (Monday, December 23, 1996)]
[Proposed Rules]
[Pages 67512-67515]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-32120]
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DEPARTMENT OF THE TREASURY
26 CFR Part 1
[REG-252231-96]
RIN 1545-AU72
Continuity of Interest
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations providing that the
continuity of shareholder interest requirement for corporate
reorganizations is satisfied if the
[[Page 67513]]
acquiring corporation furnishes consideration which represents a
proprietary interest in the affairs of the acquiring corporation and
such consideration represents a substantial part of the value of the
stock or properties transferred. Dispositions of stock of the acquiring
corporation by a former target shareholder generally are not taken into
account in determining whether continuity of shareholder interest has
been satisfied. This document also provides notice of a public hearing
on these proposed regulations.
DATES: Comments must be received by March 24, 1997. Requests to speak
and outlines of topics to be discussed at the public hearing scheduled
for Wednesday, May 7, 1997 must be received by Wednesday, April 16,
1997.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-252231-96), room
5228, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. In the alternative, submissions may be hand
delivered between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG-
252231-96), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the Internet by selecting the ``Tax Regs''
option on the IRS Home Page, or by submitting comments directly to the
IRS Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in the Auditorium,
Internal Revenue Building, 1111 Constitution Avenue NW., Washington,
DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Phoebe
Bennett, (202) 622-7750; concerning submissions and the hearing,
Christina Vasquez, (202) 622-6808 (not toll-free numbers).
SUPPLEMENTARY INFORMATION: This document contains proposed amendments
to the Income Tax Regulations (26 CFR part 1) under section 368. The
proposed regulations provide that the continuity of shareholder
interest (COSI) requirement is satisfied if the acquiring corporation
furnishes consideration which represents a proprietary interest in the
affairs of the acquiring corporation and such consideration represents
a substantial part of the value of the stock or properties transferred.
Background
The Internal Revenue Code of 1986 (Code) provides general
nonrecognition treatment for reorganizations specifically described in
section 368 of the Code. Literal compliance with the statutory
requirements is not sufficient for nonrecognition. For example, to
qualify as a reorganization the COSI requirement must also be
satisfied.
The early statutory definitions of reorganizations did not specify
the type of consideration required for a transaction to qualify as a
reorganization. As a result, a transaction may have satisfied the
literal definition of a reorganization even if the transaction
resembled a sale. To prevent such transactions from qualifying as
reorganizations, the COSI requirement was established by the courts to
ensure that the consideration furnished by the acquiring corporation
represented a proprietary interest in the affairs of the acquiring
corporation and that such consideration represented a substantial part
of the value of the stock or properties transferred. See Helvering v.
Minnesota Tea Co., 296 U.S. 378 (1935); Pinellas Ice & Cold Storage Co.
v. Commissioner, 287 U.S. 462 (1933); Cortland Specialty Co. v.
Commissioner, 60 F.2d 937 (2d Cir. 1932), cert. denied 288 U.S. 599
(1933). ``Reorganization, merger and consolidation are words indicating
corporate readjustments of existing interests. They all differ
fundamentally from a sale where the vendor corporation parts with its
interest for cash and receives nothing more.'' Cortland, 60 F.2d at
939.
The cases that gave rise to the COSI requirement did not involve
situations in which shareholders of the target corporation disposed of
stock consideration from the acquiring corporation after having
received it. In those cases, the relevant inquiry was whether the
acquiring corporation furnished the proper type of consideration in the
reorganization. Over the years, issues have arisen regarding whether
the COSI requirement is satisfied if the target shareholders, as
contemplated at the time of the reorganization, subsequently dispose of
the stock received from the acquiring corporation. Compare McDonald's
Restaurants of Illinois, Inc. v. Commissioner, 688 F.2d 520 (7th Cir.
1982), rev'g McDonald's of Zion v. Commissioner, 76 T.C. 972 (1981),
with Penrod v. Commissioner, 88 T.C. 1415 (1987). Various bar
associations have asked the Treasury Department and the IRS to provide
guidance to clarify existing law and reduce uncertainty in applying
COSI principles in the context of postreorganization sales. See New
York State Bar Association Tax Section, Postreorganization Continuity
of Interest, reprinted in 73 Tax Notes 481 (1996); Committee on
Taxation of Corporations of the Association of the Bar of the City of
New York, Postreorganization Transactions and Continuity of Shareholder
Interest, reprinted in 72 Tax Notes 1401 (1996).
Explanation of Proposed Regulations
The proposed regulations provide that the COSI requirement is
satisfied if the acquiring corporation furnishes consideration in the
reorganization that represents a proprietary interest in the affairs of
the acquiring corporation and such consideration represents a
substantial part of the value of the stock or properties transferred.
Dispositions of stock of the acquiring corporation by a former target
shareholder generally are not taken into account in determining whether
COSI has been satisfied. However, the proposed regulations emphasize
that all facts and circumstances must be considered in determining
whether the acquiring corporation has in substance furnished the
required consideration. For example, if the acquiring corporation or a
related party (within the meaning of section 707(b)(1) or section
267(b) (without regard to section 267(e))) purchases the acquiring
corporation stock shortly after the reorganization, all of the facts
and circumstances may indicate that the transaction should be properly
recast to treat the acquiring corporation as furnishing cash in the
reorganization, in which case the reorganization would not satisfy the
COSI requirement. This approach refocuses the COSI requirement on its
initial purpose of ensuring that the acquiring corporation furnishes
the proper type of consideration and also promotes simplicity and
administrability in applying the COSI requirement.
Effect on Other Authorities
The proposed regulations do not specifically address the effect on
COSI of dispositions of target stock before a transaction potentially
qualifying as a reorganization. See, e.g., King Enterprises, Inc. v.
United States, 418 F.2d 511 (Ct. Cl. 1969); J.E. Seagram Corp. v.
Commissioner, 104 T.C. 75 (1995); Superior Coach of Florida, Inc. v.
Commissioner, 80 T.C. 895 (1983); Yoc Heating Corp. v. Commissioner, 61
T.C. 168 (1973). The Treasury Department and IRS are studying this
question and also the role of the COSI requirement in section
368(a)(1)(D) reorganizations and section 355 transactions. See
Sec. 1.355-2(c). The Treasury Department and IRS solicit comments on
these issues.
[[Page 67514]]
Effect on Other Documents
The IRS will modify or obsolete publications as necessary to
conform with this regulation as of the date of publication in the
Federal Register of the final regulations. See, e.g., Rev. Proc. 86-42
(1986-2 C.B. 722); Rev. Proc. 77-37 (1977-2 C.B. 568). The IRS solicits
comments as to whether other publications should be modified or
obsoleted.
Proposed Effective Date
The revisions and additions in the proposed regulations apply to
transactions occurring after these regulations are published as final
regulations in the Federal Register, except that they shall not apply
to any transactions occurring pursuant to a written agreement which is
(subject to customary conditions) binding on or before these
regulations are published as final regulations in the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and because the
regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight copies) or comments transmitted via Internet that are
submitted timely to the IRS. All comments will be available for public
inspection and copying.
A public hearing has been scheduled at 10 a.m. on Wednesday, May 7,
1997, in the Auditorium, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington DC. Because of access restrictions, visitors
will not be admitted beyond the Internal Revenue Building lobby more
than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
request to speak by Wednesday, April 16, 1997, and submit an outline of
the topics to be discussed and the time to be devoted to each topic by
Wednesday, April 16, 1997.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal author of these regulations is Phoebe Bennett of the
Office of the Assistant Chief Counsel (Corporate), IRS. However, other
personnel from the IRS and Treasury Department participated in their
development.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805. * * *
Par. 2. Section 1.368-1 is amended by:
1. Revising the third sentence of paragraph (b).
2. Adding two sentences between the fourth and fifth sentences of
paragraph (b).
3. Adding paragraph (e).
The revisions and additions read as follows:
Sec. 1.368-1 Purpose and scope of exception of reorganization
exchanges.
* * * * *
(b) * * * Requisite to a reorganization under the Code are a
continuity of the business enterprise under the modified corporate
form, and (except as provided in section 368(a)(1)(D)) a continuity of
shareholder interest. * * * The continuity of shareholder interest
requirement is described in paragraph (e) of this section. The third
and fifth sentences of this paragraph apply to transactions occurring
after these regulations are published as final regulations in the
Federal Register, except that they shall not apply to any transactions
occurring pursuant to a written agreement which is (subject to
customary conditions) binding on or before these regulations are
published as final regulations in the Federal Register. * * *
* * * * *
(e) Continuity of shareholder interest--(1) General rule. The
purpose of the continuity of shareholder interest requirement is to
prevent transactions that resemble sales from qualifying for
nonrecognition of gain or loss available to corporate reorganizations.
Continuity of shareholder interest requires that the acquiring
corporation furnish consideration representing a proprietary interest
in the affairs of the acquiring corporation and that such consideration
represents a substantial part of the value of the stock or properties
transferred. In determining whether the acquiring corporation has
furnished such consideration, all facts and circumstances must be
considered, including any plan or arrangement for the acquiring
corporation or its successor corporation (or a person related to the
acquiring corporation or its successor corporation within the meaning
of section 707(b)(1) or section 267(b) (without regard to section
267(e))) to redeem or acquire the consideration provided in the
reorganization. Thus, for example, if based on all the facts and
circumstances the acquiring corporation has furnished solely cash, the
continuity of shareholder interest requirement is not satisfied.
(2) Triangular reorganizations. For purposes of this paragraph (e),
in the case of a triangular reorganization described in Sec. 1.358-
6(b), the continuity of shareholder interest requirement will be
applied with reference to the stock of the corporation which is in
control of the acquiring corporation (in a forward triangular merger)
or in control of the merged corporation (in a reverse triangular
merger).
(3) Examples. The following examples illustrate the application of
this paragraph (e):
Example 1. A owns all of the stock of T. T merges into P. In the
merger, A receives stock of P having a fair market value of $50x and
cash of $50x. Immediately after the merger, and pursuant to a
preexisting binding contract negotiated by A, A sells all of the
stock of P received by A in the merger to B, a party not related to
P. The transaction satisfies the continuity of shareholder interest
requirement because A received stock of P representing a substantial
part of the value of the total consideration transferred in the
acquisition.
Example 2. A owns 80 percent of the stock of T and none of the
stock of P, which is widely held. T merges into P. In the merger, A
receives stock of P. In addition, A obtains registration rights
pursuant to an agreement with P to register the P stock and sells
such stock shortly after the acquisition in the open market. The
transaction satisfies the continuity of shareholder interest
requirement.
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Example 3. A owns 80 percent of the stock of T and none of the
stock of P. T merges into P. In the merger, A receives stock of P.
In addition, A arranges with an independent investment banker to
hedge the risk of loss on the P stock received in the merger.
Neither P nor a party related to P enters directly or indirectly
into the hedging transaction. The transaction satisfies the
continuity of shareholder interest requirement.
Example 4. A owns 80 percent of the stock of T and none of the
stock of P. T merges into P. In the merger, A receives stock of P
but with an agreement that it will be redeemed shortly by P.
Pursuant to the agreement, shortly after the merger P redeems all of
the stock of P received by A in the merger for cash. Under all of
the facts and circumstances, the cash is treated as furnished by P
in the merger, so that the merger does not satisfy the continuity of
shareholder interest requirement. The result is the same if S, P's
wholly owned subsidiary, buys all of the stock of P received by A in
the merger for cash. The result is also the same if pursuant to a
plan between P, its investment banker, and A, P's investment banker
buys all of the stock of P received by A in the merger for cash and,
shortly thereafter, P redeems the stock held by the investment
banker for cash.
(4) Effective date. Paragraph (e) applies to transactions occurring
after these regulations are published as final regulations in the
Federal Register, except that it shall not apply to any transactions
occurring pursuant to a written agreement which is (subject to
customary conditions) binding on or before these regulations are
published as final regulations in the Federal Register.
Par. 3. In Sec. 1.368-2, paragraph (a) is amended by removing the
second sentence and adding two new sentences in its place to read as
follows:
Sec. 1.368-2 Definition of terms.
(a) * * * The term does not embrace the mere purchase by one
corporation of the properties of another corporation. The preceding
sentence applies to transactions occurring after these regulations are
published as final regulations in the Federal Register, except that it
shall not apply to any transactions occurring pursuant to a written
agreement which is (subject to customary conditions) binding on or
before these regulations are published as final regulations in the
Federal Register. * * *
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-32120 Filed 12-20-96; 8:45 am]
BILLING CODE 4830-01-P
